Leases for gas drillers don't last forever
Robert Burnett hears from clients about expiring gas leases "almost every day" from his position as chair of the oil and gas group at the Downtown-based Houston Harbaugh law firm.
Which makes sense, considering a day is all it takes to invite a host of legal concerns and questions into leasing litigation. Leases that grant drillers the right to excavate gas from a property don't last forever, and if a firm is slow to set up the rig, a lease can expire without ever being activated.
The chance to renegotiate can be a windfall for savvy landowners, and a costly proposition for drillers. The result, said Mr. Burnett, is a growing number of cases that are trying to determine the way forward for leases approaching an end date without any substantial operations on the property.
Though the first deep well broke into the Marcellus Shale rock in 2004, leasing activity really picked up several years later, as billion-dollar players moved in and tried to snatch up land before their competitors. Most leases signed in 2007 and 2008 were for five-year terms, meaning many that never saw drilling are coming close to expiration now.
The terms of the expiration language can mean a difference of hundreds of thousands of dollars for leaseholders. In the early days of drilling, firms could present agreements without as much competition as they see now. At this point, expiring leases can give landowners who felt low-balled in the past the chance to renegotiate for more lucrative terms.
But to rule whether a lease is activated by drilling operations and therefore not expired, lawyers must rely on a legal gray area that determines what level of drilling operations constitutes an "active" lease.
"If you're negotiating a lease, the gas operator wants [the expiration language] to be as broad as possible," Mr. Burnett said. "And landowners want it to be as specific as possible."
To help clients faced with an impending expiration, Mr. Burnett has written a questionnaire that examines what cause for litigation a landowner might have.
• Is there a well on the property that's producing gas?
Easy answer: If there is, that lease is activated.
• If there's not a producing well, take a look at the lease language to see what it says about what constitutes an "active" well site.
Drillers don't necessarily need to erect a complete rig to activate a lease. There have been horror stories across the state of landowners frustrated by drillers who park a truck or dig a ditch to lock the lease terms into place.
"Is parking a bulldozer on the well pad site enough? Probably not," Mr. Burnett said.
The law often requires drillers to demonstrate that they are "drilling in good faith" -- that is, if they do park a truck one day, that they return the next as part of continuing operations.
• Has the land been pooled into a bigger holding?
Drillers often pool several leased properties into a larger pool, and drilling anywhere on the holding activates all of the leases that comprise it. It's possible that operations occurring elsewhere in the pool have activated the lease.
• Is there an extension clause?
To understand lease expiration litigation, it helps to understand the stages a lease can enter. The typical five-year agreement, which includes details on any signing bonus or royalty payments, is called the primary term. If sufficient drilling activities start on the property, the lease enters its secondary term.
Secondary terms can stretch for decades and last as long as there is a producing well on the property.
"I have clients that have leases that are well into their secondary term because the primary term expired in 1905," said Mr. Burnett, referring to the decades-old shallow wells that have long been in Pennsylvania.
Overall, Pennsylvania law remains murky on what constitutes "sufficient" drilling operations, said Mr. Burnett. States such as Texas and Oklahoma, which have seen more drilling for more years, have more settled law on the matter.
He expects Pennsylvania appellate courts to provide more guidance over the next two years or so.
In the meantime, drillers have started to compete with one another for those land parcels coming up on lease expiration.
If a lease is set to expire soon, drillers will often introduce a so-called "top lease" to the landowner, which essentially extends the driller's right to develop on the land. Top leases are activated only after the original lease expires, and landowners often collect a signing bonus for agreeing to take on the extension.
But companies playing catch-up and trying to secure valuable land they missed the first time around have complicated matters, Mr. Burnett said. Now, it's not uncommon for a competing driller to introduce top leases to landowners who signed with a competitor, in the hopes of snatching up the leasehold once the original terms expire.
First Published October 1, 2012 12:00 am